Under Council Directive 2003/49/EC of 3 June (the Interest and Royalty Directive), interest (and royalty) payments between associated companies in different EU member states are exempt from withholding tax, provided certain conditions are met. The primary aim of this directive is to avoid double taxation and reduce compliance costs, treating cross-border transactions as if they were domestic.
However, companies based in European Economic Area (EEA) countries – particularly Norway, Iceland, and Liechtenstein – remain subject to withholding tax in Portugal despite meeting the same substantive requirements. This may constitute a form of tax discrimination. This article focuses specifically on interest payments between associated companies.
The Portuguese tax regime
In Portugal, interest payments made by resident entities, or by permanent establishments of non-resident entities, are generally subject to withholding tax at a rate of 25%, at the moment the income becomes due, regardless of actual payment.
This rate may be reduced under a double tax treaty (DTT), provided that the required documentation proving non-residence status is duly submitted. However, when payments are made between associated companies within the EU, an income tax exemption applies under Article 14(12) of the Portuguese Corporate Income Tax Code, provided that certain conditions are met.
In a nutshell, to qualify for the withholding tax exemption, the following requirements must be satisfied.
The beneficial owner of the interest:
Is resident in another EU member state;
Is subject to corporate tax without being exempt; and
Takes one of the legal forms listed in the directive.
The companies are “associated”, which means that for a continuous period of at least two years:
One holds directly at least 25% of the capital of the other; or
Both are at least 25% owned by the same third company.
This exemption does not apply where the arrangement lacks economic substance or where the formal documentation requirements are not met.
Grounds for tax discrimination
Portuguese legislation limits the withholding tax exemption under Article 14(12) of the Corporate Income Tax Code exclusively to EU-resident companies, thereby excluding companies resident in EEA countries (with the exception of Switzerland, in which case the same tax regime applies). This exclusion may breach the principles of freedom of establishment and free movement of capital, both enshrined in the Agreement on the European Economic Area (the EEA Agreement).
According to articles 31 and 40 of the EEA Agreement, freedom of establishment applies equally to nationals of EU member states and European Free Trade Association states (Norway, Iceland, and Liechtenstein), and free movement of capital must not be restricted or discriminated against on the grounds of nationality, residence, or location of investment. Therefore, the differentiated treatment of companies established in EEA countries – despite meeting identical ownership, beneficial ownership, and economic substance criteria – violates the principle of non-discrimination and undermines the objectives of the EEA Agreement.
In practice, multinational groups with legitimate intragroup financing structures (e.g., cash pooling or shareholder loans) between Portuguese companies and any associated entities in Norway, Iceland, or Liechtenstein remain subject to taxation that does not apply in similar EU corporate relationships.
A similar situation occurred under the domestic implementation of the Parent–Subsidiary Directive, where the tax exemption was initially limited to EU-based companies. However, the Portuguese legislator amended that regime, and withholding tax exemptions on dividend payments are now extended to qualifying EEA entities that meet the same conditions.
Constitutional framework and practical relevance
Moreover, under the Portuguese Constitution, international treaties duly ratified by, and in force in, Portugal take precedence over the domestic legislation. Consequently, the provisions of the EEA Agreement prevail over Portuguese legislation.
Key takeaway
While withholding tax must be assessed on a case-by-case basis (including under any applicable DTT), the mere existence of a DTT would not automatically remedy the discriminatory nature of the domestic rule. Companies with genuine funding agreements between Portugal and EEA countries (Norway, Iceland, or Liechtenstein) that meet the conditions laid out in the Interest and Royalty Directive have valid legal grounds to claim reimbursement of withheld taxes on interest (and royalties) in principle regarding the past four years.
